You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and related Notes thereto, included in Part IV, Item 15 of this Report, and the “Risk Factors” section at the end of this Item 7 as well as other cautionary statements and risks described elsewhere in this Report, before deciding to invest in our company or to maintain or increase your investment. In this Report, all share numbers and per share amounts have been retroactively adjusted to reflect our 2-for-1 stock splits, each in the form of a 100% stock dividend, effective February 17, 1999 and February 11, 2000.

Overview

      Broadcom Corporation is the leading provider of highly integrated silicon solutions that enable broadband communications and networking of voice, video and data services. Using proprietary technologies and advanced design methodologies, Broadcom designs, develops and supplies complete system-on-a-chip solutions and related hardware and software applications for every major broadband communications market. Our diverse product portfolio includes solutions for digital cable and satellite set-top boxes; cable and DSL modems and residential gateways; high-speed transmission and switching for local, metropolitan, wide area and storage networking; home and wireless networking; cellular and terrestrial wireless communications; VoIP, gateway and telephony systems; broadband network processors; and SystemI/O server solutions.

      From Broadcom’s inception in 1991 through 1994, we were primarily engaged in product development and the establishment of strategic customer and foundry relationships. During that period, we generated the majority of our revenue from development work performed for key customers. We began shipping our products in 1994, and subsequently our revenue has increased predominantly through sales of our semiconductor products. We intend to continue to enter into development contracts with key customers, but expect that future development revenue will constitute a small percentage of our total revenue. We also generate a small percentage of our product revenue from the licensing of software and the provision of software support services and from licenses of system-level reference designs. We utilize independent foundries to manufacture all of our semiconductor products.

      Net Revenue. The percentage of our net revenue derived from independent customers located outside of the United States was approximately 25.1% for 2002, 23.3% for 2001 and 20.3% for 2000. All of our revenue to date has been denominated in U.S. dollars. See Note 12 of Notes to Consolidated Financial Statements.

      From time to time, our key customers have placed large orders causing our quarterly net revenue to fluctuate significantly. We expect these fluctuations will continue.

      Sales to our significant customers, including sales to their manufacturing subcontractors, as a percentage of net revenue are as follows:

*	Less than 10% of net revenue.

(1)	Includes sales to Compaq, which was acquired by Hewlett-Packard in May 2002, for all periods presented.

     We expect that our largest customers will continue to account for a substantial portion of our net revenue in 2003 and for the foreseeable future. These customers and their respective contributions to our net revenue have varied and will likely continue to vary from period to period.

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      Gross Margin. Our gross margin has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following:

	•	our product mix and volumes;
	•	the position of our products in their respective life cycles;
	•	the effects of competition and competitive pricing strategies;
	•	manufacturing cost efficiencies and inefficiencies;
	•	fluctuations in direct product costs and overhead costs such as prototyping expenses;
	•	amortization of purchased intangible assets;
	•	stock-based compensation expense;
	•	licensing and royalty arrangements; and
	•	the mix of product revenue and development revenue.

      Product Cycles. The cycle for test, evaluation and adoption of our products by customers can range from three to six months or more, with an additional three to nine months or more before a customer commences volume production of equipment incorporating our products. Moreover, in light of the continuing significant economic slowdown in the technology sector, it may take significantly longer than three to nine months before customers commence volume production of equipment incorporating some of our products. Due to this lengthy sales cycle, we may experience significant delays from the time we incur expenses for research and development, selling, general and administrative efforts, and investments in inventory, and the generation of corresponding revenue, if any. We anticipate that the rate of new orders may vary significantly from month to month. If anticipated sales and shipments in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our results of operations for that quarter, and potentially for future quarters, would be materially and adversely affected.

      Acquisition Strategy. A key element of our business strategy involves the acquisition of businesses, products or technologies that allow us to reduce the time required to develop new technologies and products and bring them to market, complement our existing product offerings, expand our market coverage, increase our engineering workforce or enhance our technological capabilities. We plan to continue to evaluate strategic opportunities as they arise, including business combination transactions, strategic partnerships, capital infusions and the purchase or sale of assets.

      During 2002, 2001 and 2000 we completed 13 acquisitions that were accounted for using the purchase method of accounting, for original aggregate equity consideration of $6.349 billion. In 2002 we acquired Mobilink Telecom, Inc., a supplier of chipsets and reference designs for use in cellular phones, cellular modem cards and wireless PDAs. In 2001 we acquired Visiontech Ltd., a supplier of digital video/ audio MPEG-2 compression and decompression chips; ServerWorks Corporation, a supplier of high-performance system input/ output integrated circuits for servers, workstations and storage platforms; KimaLink, a developer of integrated circuits for wireless data communications; and PortaTec Corporation, a developer of integrated solutions for smart mobile devices. In 2000 we acquired Innovent Systems, Inc., a developer of radio frequency integrated circuits for wireless data communications; Puyallup Integrated Circuit Company, Inc., a provider of integrated circuit design services; Altima Communications, Inc., a supplier of networking integrated circuits for the small-to-medium sized business networking market; NewPort Communications, Inc., a supplier of mixed-signal integrated circuits for the high-speed communications infrastructure market; Silicon Spice Inc., a developer of communications processors and other technology for high-density voice, fax and data packet transmission over wide area networks; Element 14, Inc., a developer of high-port density, low-power digital subscriber line chipsets, software and communications processor technology; Allayer Communications, a developer of high-performance enterprise and optical networking communications chips; and SiByte, Inc., a developer of high-performance microprocessor solutions for broadband networking. Because each of these acquisitions was accounted for as a purchase transaction, the accompanying consolidated financial statements include the results of operations of the acquired

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      In addition, during 2000 we completed four acquisitions that were accounted for using the pooling-of-interests method of accounting. These acquisitions included Digital Furnace Corporation, a developer of communications algorithms and software that increase the capacity of existing broadband networks for interactive services; BlueSteel Networks, Inc., a developer of high-performance Internet security processors for e-commerce and VPN applications; Stellar Semiconductor, Inc., a developer of 3D graphics technology; and Pivotal Technologies Corporation, a developer of high-performance communications links for both wired and wireless environments. Because each of these acquisitions was accounted for as a pooling-of-interests transaction, our historical consolidated financial statements and the discussion and analysis of financial condition and results of operations for prior periods have been restated to include the operations of these four companies as if they had been combined with our company at the beginning of the first period presented. Included in restated net revenue and net loss for 2000 were revenue and net losses, aggregating $300,000 and $8.8 million, respectively, from the four pooling-of-interests transactions completed in that year and incurred prior to the respective closings of those transactions.

Critical Accounting Policies and Estimates

      The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses during the reporting period. We regularly evaluate our estimates and assumptions related to allowances for doubtful accounts, sales returns and allowances, warranty reserves, inventory reserves, goodwill and purchased intangible asset valuations, strategic investments, deferred income tax asset valuation allowances, restructuring costs, litigation and other contingencies. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

      We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our consolidated financial statements:

	•	Revenue, Receivables and Inventory. We recognize product revenue upon concluding that all of the fundamental criteria for revenue recognition have been met. The criteria are usually met at the time of product shipment, except for shipments to stocking distributors where revenue is recognized upon sale to the end customer. In addition, we record reductions to revenue for estimated product returns and allowances such as competitive pricing programs and rebates. Additional reductions to revenue would result if actual product returns or pricing adjustments exceed our estimates. Our products typically carry a one to three year warranty. We provide reserves for estimated product warranty costs at the time revenue is recognized. Although we engage in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, use of materials and service delivery costs incurred in correcting any product failure. Should actual product failure rates, use of materials or service delivery costs differ from our estimates, additional warranty reserves could be required, which could reduce gross margins. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated realizable value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs could be required.
	•	Goodwill and Purchased Intangible Assets. The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the

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		net tangible and intangible assets acquired, including in-process research and development, or IPR&D. Goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. The amounts and useful lives assigned to intangible assets impact future amortization, and the amount assigned to IPR&D is expensed immediately. If the assumptions and estimates used to allocate the purchase price are not correct, purchase price adjustments or future asset impairment charges could be required.
	•	Impairment of Goodwill and Other Intangible Assets. The value of our intangible assets, including goodwill, could be impacted by future adverse changes such as (i) any future declines in our operating results, (ii) another significant slowdown in the technology sector and the semiconductor industry or a continuation or an increase in severity of the existing significant economic slowdown or (iii) any failure to meet the performance projections included in our forecasts of future operating results. We evaluate these assets used in operations, including purchased intangible assets deemed to have indefinite lives, on an annual basis or more frequently if indicators of impairment exist. In the process of our annual impairment review, we primarily use the income approach methodology of valuation that includes the discounted cash flow method as well as other generally accepted valuation methodologies to determine the fair value of our assets. Significant management judgment is required in the forecasts of future operating results that are used in the discounted cash flow method of valuation. The estimates we have used are consistent with the plans and estimates that we use to manage our business. It is reasonably possible, however, that the plans and estimates used may be incorrect. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.
	•	Strategic Investments. We have made strategic investments in publicly traded and privately held companies for the promotion of business and strategic objectives. Strategic investments with less than a 20% voting interest are generally carried at cost. We will use the equity method to account for strategic investments in which we have a voting interest of 20% to 50% or in which we otherwise have the ability to exercise significant influence. Under the equity method, the investment is originally recorded at cost and adjusted to recognize our share of net earnings or losses of the investee, limited to the extent of our investment in, advances to and financial guarantees for the investee that create additional basis in the investee. The share prices of the publicly traded securities have been volatile, and the value of the non-publicly traded securities is difficult to determine. We periodically review these investments for other-than-temporary declines in fair value based on the specific identification method and write down investments to their fair value, with a corresponding loss recorded in other expense in the statement of operations, when an other-than-temporary decline has occurred. We generally believe an other-than-temporary decline has occurred when the fair value of the investment is below the carrying value for two consecutive quarters, absent evidence to the contrary. Fair values for investments in public companies are determined using their quoted market prices. Fair values for investments in privately held companies are estimated based upon one or more of the following: pricing models using historical and forecasted financial information, the values of recent rounds of financing, and/or quoted market prices of comparable public companies. Although we believe our estimates reasonably reflect the fair value of the non-publicly traded securities held by us, had there been an active market for the equity securities, the carrying values might have been materially different than the amounts reported. Future adverse changes in market conditions or poor operating results of companies in which we have made such investments could result in losses or an inability to recover the carrying values of the investments that may not be reflected in the investments’ current carrying values and which could require a future impairment charge.
	•	Deferred Taxes. We record a valuation allowance to reduce our deferred tax assets to the amount that we believe is more likely than not to be realized. In assessing the need for a valuation allowance, we consider all positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and recent financial performance. As a result of our recent cumulative losses and the full utilization of our loss carryback potential, we recently concluded that a full valuation allowance against our net deferred tax assets was appropriate. If, in the future, we believe that

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		we will realize a deferred tax asset which currently has a valuation allowance, we would record a reduction to income tax expense in the period of such determination.
	•	Restructuring Charges. Over the last several quarters we have undertaken, and we may continue to undertake, significant restructuring initiatives, which have required us to develop formalized plans for exiting certain business activities. We have had to record estimated expenses for lease cancellations, long-term asset write-downs, severance and outplacement costs and other restructuring costs. Given the significance of, and the timing of the execution of such activities, this process is complex and involves periodic reassessments of estimates made at the time the original decisions were made. Through 2002, the accounting rules for restructuring costs and asset impairments required us to record provisions and charges when we had a formal and committed plan. In calculating the cost to dispose of our excess facilities, we had to estimate our future space requirements and the timing of exiting excess facilities and then estimate for each location the future lease and operating costs to be paid until the lease is terminated and the amount, if any, of sublease income. This required us to estimate the timing and costs of each lease to be terminated, including the amount of operating costs and the rate at which we might be able to sublease the site. To form our estimates for these costs, we performed an assessment of the affected facilities and considered the current market conditions for each site. Our assumptions on future space requirements, the operating costs until termination or the offsetting sublease revenues may turn out to be incorrect, and our actual costs may be materially different from our estimates, which could result in the need to record additional costs or to reverse previously recorded liabilities. Our policies require us to periodically evaluate the adequacy of the remaining liabilities under our restructuring initiatives. As management continues to evaluate the business, there may be additional charges for new restructuring activities as well as changes in estimates to amounts previously recorded.

Results of Operations

      The following table sets forth certain statement of operations data expressed as a percentage of net revenue for the periods indicated:

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     Years Ended December 31, 2002 and 2001

      Net Revenue. Our revenue consists principally of product revenue generated by sales of our semiconductor products, and to a much lesser extent, from development revenue generated under development contracts with our customers and licenses of software and the provision of software support services. Net revenue is revenue less provisions for returns and allowances. Net revenue for 2002 was $1.083 billion, an increase of $121.1 million or 12.6% as compared with net revenue of $961.8 million for 2001. Net revenue was reduced by $25.5 million for 2001 to account for the fair value of the performance-based warrants to purchase shares of Class A common stock earned by certain customers in connection with purchase and development agreements that we assumed in prior acquisitions. No comparable performance-based warrants were earned in 2002, and there were no remaining outstanding performance-based warrants at December 31, 2002.

      The increase in net revenue for 2002 as compared to 2001 resulted primarily from an increase in volume shipments of our enterprise networking and SystemI/O server products, as well as increased contributions from our emerging businesses, including those in the areas of wireless local area networking, Bluetooth, personal video recording and mobile communications applications. This increase was offset in part by a decrease in shipments of our semiconductor products for digital cable set-top boxes and lower average selling prices on cable modem products. We experienced modest sequential quarterly revenue growth in 2002 and expect revenue to continue to grow in the first quarter of 2003.

      Gross Profit. Gross profit represents net revenue less the cost of revenue. Cost of revenue includes the cost of purchasing the finished silicon wafers manufactured by independent foundries, costs associated with assembly, packaging, test and quality assurance for semiconductor products, prototyping costs, amortization of purchased technology, and manufacturing overhead, including costs of personnel and equipment associated with manufacturing support, and contracted development work. Gross profit for 2002 was $478.6 million or 44.2% of net revenue, an increase of $74.5 million or 18.4% from gross profit of $404.1 million or 42.0% of net revenue for 2001.

      The increase in gross profit as a percentage of net revenue resulted primarily from increased volumes and improved yields which reduced subcontractor costs, increased absorption of fixed overhead costs as a result of the increased volumes, and lower stock-based compensation expense, offset in part by competitive pricing strategies and amortization of purchased intangible assets.

      Approximately $12.9 million and $15.9 million of stock-based compensation expense were included in cost of revenue for 2002 and 2001, respectively. Approximately $56.0 million and $51.7 million of amortization of purchased intangible assets were included in cost of revenue for 2002 and 2001, respectively. At December 31, 2002 the unamortized balance of purchased intangible assets that will be amortized to cost of revenue in the future was $21.4 million, of which $16.1 million and $5.3 million are expected to be amortized in 2003 and 2004, respectively.

      We anticipate that gross profit will continue to be impacted by the non-cash amortization of acquisition-related charges. In addition, gross profit has been and will likely continue to be impacted in the future by competitive pricing strategies, fluctuations in the volume of our product sales, fluctuations in silicon wafer costs, and possible future changes in product mix and the introduction of certain lower margin products, among other factors.

      Research and Development Expense. Research and development expense consists primarily of salaries and related costs of employees engaged in research, design and development activities, costs related to engineering design tools, subcontracting costs, systems level testing and prototyping costs, and facilities expenses. Research and development expense does not include expense amounts associated with stock-based compensation of employees engaged in research and development or expense amounts associated with amortization of purchased intangible assets related to research and development. Research and development expense for 2002 was $461.8 million or 42.6% of net revenue, an increase of $15.2 million or 3.4% as compared with research and development expense of $446.6 million or 46.4% of net revenue for 2001. The increase in absolute dollars resulted primarily from the addition of personnel through our acquisition of Mobilink, certain strategic new hires, and investment in design tools for the development of new products and the enhancement of existing products, offset in part by cost

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      Selling, General and Administrative Expense. Selling, general and administrative expense consists primarily of personnel-related expenses, professional and legal fees, facilities expenses, communications expenses and trade show expenses. Selling, general and administrative expense does not include expense amounts associated with stock-based compensation of administrative employees or expense amounts associated with amortization of purchased intangible assets. Selling, general and administrative expense for 2002 was $165.3 million or 15.3% of net revenue, an increase of $9.8 million or 6.3% as compared with selling, general and administrative expense of $155.4 million or 16.2% of net revenue for 2001. This increase reflected higher personnel-related costs resulting from the addition of certain strategic new hires as well as increased facilities expenses and legal fees, offset in part by cost reductions from our restructuring plan. As a result of our October 2002 restructuring plan, we anticipate a slight decrease in personnel-related selling, general and administrative expense in the near term. Notwithstanding the anticipated immediate impact of our restructuring plan, based upon past experience, we anticipate that over the long term selling, general and administrative expense in absolute dollars will continue to increase to support any expansion of our operations through indigenous growth and acquisitions, as a result of periodic changes in our infrastructure to support any increased headcount, acquisition and integration activities, and international operations, and in view of the volume of current litigation.

      Stock-Based Compensation Expense. Stock-based compensation expense generally represents the amortization of deferred compensation as well as expense related to options subject to variable accounting. Deferred compensation is presented as a reduction of shareholders’ equity and is amortized ratably over the respective vesting periods of the applicable options, generally three to five years. Deferred compensation primarily represents the difference between the fair value of our common stock at the measurement date of each acquisition and the exercise price of the unvested stock options assumed in the acquisition. Additional deferred compensation related to earned contingent consideration is measured and recorded at the date the contingency is met. We recorded approximately $2.2 million of net deferred compensation for 2002 and $377.9 million of deferred compensation for 2001, primarily in connection with stock options assumed in our acquisitions. Approximately $103.0 million and $84.6 million of deferred compensation was eliminated due to employee terminations during 2002 and 2001, respectively.

      Stock-based compensation expense for 2002 was $359.8 million or 33.1% of net revenue, a decrease of $124.2 million or 25.7% as compared with stock-based compensation expense of $484.0 million or 50.3% of net revenue for 2001. The decrease in stock-based compensation expense related primarily to the elimination of deferred compensation due to the termination of certain employees and the decrease in our year end stock price, which is used to remeasure stock-based compensation for options subject to variable accounting. Approximately $12.9 million and $15.9 million of additional stock-based compensation expense were classified as cost of revenue for 2002 and 2001, respectively. Approximately $47.0 million and $11.1 million for 2002 and 2001, respectively, of additional stock-based compensation expense were classified as restructuring costs resulting from an extension of the exercise period for vested stock options of the employees terminated in connection with our restructuring plans and the acceleration of the vesting period of certain stock options of certain terminated employees as required by their assumed option agreements.

      Outstanding stock options assumed in certain acquisitions are subject to variable accounting and will be revalued quarterly over their vesting periods until the earlier of (i) all of the performance goals have been met, (ii) the time period in which all of the performance goals may be met has lapsed, whether the goals have been satisfied or not, or (iii) the options are exercised. If any of the applicable options are forfeited, cancelled or expire, any related previously recorded stock-based compensation expense will be reversed. In addition, if there is a

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      In connection with certain of our acquisitions, if specified future internal performance goals are satisfied, the aggregate consideration for these acquisitions will be increased. At December 31, 2002 a total of 3,534,177 shares of Class A common stock were reserved for future issuance if the remaining internal performance goals established in connection with our acquisitions of ServerWorks Corporation and Mobilink are met. If the remaining internal performance goals had been met at December 31, 2002, additional equity consideration of approximately $53.2 million, based on the closing price of our Class A common stock on December 31, 2002, would have been recorded and allocated between goodwill, stock-based compensation and deferred compensation. The amount of actual additional equity consideration to be recorded will vary depending on which, if any, of the remaining internal performance goals are met and the actual market values of our Class A common stock on the dates such internal performance goals are achieved.

      Amortization of Purchased Intangible Assets. Purchased intangible assets primarily include completed technology and customer relationships, contracts and backlog, and are amortized on a straight-line basis over the estimated remaining useful lives of the respective assets, ranging from one to three years. The amortization of purchased intangible assets, excluding completed technology, for 2002 was $22.4 million or 2.1% of net revenue, a decrease of $4.8 million or 17.7%, as compared with $27.2 million or 2.8% of net revenue for 2001. The decrease resulted primarily from the reclassification, as required by Statement of Financial Accounting Standards, or SFAS, No. 142, Goodwill and Other Intangible Assets , or SFAS 142, of assembled workforce as goodwill, which is no longer being amortized, offset partially by the amortization of other purchased intangibles. At December 31, 2002 the unamortized balance of purchased intangible assets that will be amortized to future operating expense was $2.6 million, all of which is expected to be amortized in 2003. In addition, approximately $56.0 million and $51.7 million of amortization of completed technology were classified as cost of revenue for 2002 and 2001, respectively.

      Impairment of Goodwill and Other Intangible Assets. During the three months ended December 31, 2002, we performed an assessment in accordance with SFAS 142 of the carrying value of the goodwill recorded in connection with our various acquisitions. In accordance with SFAS 142, we compared the carrying value of each reporting unit to its estimated fair value. We estimated the fair value of our reporting units primarily using the income approach methodology of valuation that includes the discounted cash flow method, taking into consideration the market approach and certain market multiples as verification of the values derived using the discounted cash flow methodology. In addition, publicly available information regarding the market capitalization of our company was also considered. An impairment loss was recognized for reporting units where the carrying value of their goodwill exceeded the implied fair value of goodwill. Based on this assessment and an independent valuation, we recorded a charge of $1.241 billion during 2002 to write down the value of goodwill associated with certain of our reporting units. The primary factors resulting in the impairment charge were the continued significant economic slowdown in the technology sector and the semiconductor industry, affecting both our

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      In December 2002 we purchased a patent portfolio related to integrated circuit technology for approximately $24.0 million. Although the patents purchased broaden our technology portfolio, the purchase price was expensed immediately upon acquisition as we did not have plans to currently utilize the patents 1) in our ongoing operations; 2) to generate future cash flow; or 3) for resale to a third party. In accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets , since it is not possible to reasonably forecast cash flows expected to be generated or saved as a result of the acquired patent portfolio, the patent portfolio was determined to be fully impaired at the date of acquisition.

      During 2001 we performed an assessment of the carrying values of intangible assets recorded in connection with our various acquisitions. The assessment was performed in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of , or SFAS 121, due to the significant economic slowdown and the reduction in near-term demand in the technology sector and the semiconductor industry. As a result of the assessment, we concluded that the decline in market conditions within the industry was significant and other than temporary. Based on this assessment and an independent valuation, we recorded a charge of $1.182 billion to write down the value of goodwill associated with certain of our purchase transactions.

      For further discussion of impairment of goodwill and other intangible assets, see Notes 1 and 10 of Notes to Consolidated Financial Statements.

      Restructuring Costs. From the second quarter of 2001 through the third quarter of 2002, we implemented a plan (the “2001 Restructuring Plan”) to restructure our operations in response to the challenging economic climate. As a result of the prolonged downturn in the semiconductor industry, we announced an additional restructuring program that we began implementing in the fourth quarter of 2002 (the “2002 Restructuring Plan”). Restructuring costs consist of the costs associated with the implementation of these restructuring plans. These restructuring plans focused on cost reductions and operating efficiencies, including workforce reductions and consolidation of excess facilities, and have resulted in certain business unit realignments. We recorded restructuring costs totaling $119.7 million and $34.3 million for 2002 and 2001, respectively, which were classified as operating expense in the consolidated statements of operations. We may record additional restructuring costs in 2003 as we continue to implement the 2002 plan.

      Approximately 477 and 160 employees were terminated across all of our business functions and geographic regions during 2002 and 2001, respectively. In addition, headcount was reduced through attrition and reductions in the number of temporary and contract workers employed by us. We recorded workforce reduction charges for 2002 and 2001 of approximately $66.5 million and $16.1 million, respectively, related to severance and fringe benefits. Included in these amounts are approximately $47.0 million and $11.1 million for 2002 and 2001, respectively, of stock-based compensation expense resulting from an extension of the exercise period for vested stock options of certain terminated employees and the acceleration of the vesting period of certain options of certain terminated employees as required by their assumed option agreements.

      During 2002 and 2001 we recorded charges of approximately $53.2 million and $18.2 million, respectively, for the consolidation of excess facilities. These charges related primarily to lease terminations, non-cancelable lease costs and write-offs of leasehold improvements.

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      Activity and liability balances related to the 2002 and 2001 Restructuring Plans are as follows:

(1)

Although not related to the 2002 or 2001 Restructuring Plans, we assumed additional liabilities of approximately $6.8 million in connection with the Mobilink acquisition for the consolidation of excess facilities, relating primarily to lease terminations, non-cancelable lease costs and write-offs of leasehold improvements. The liabilities related to the Mobilink acquisition have been classified as restructuring liabilities for presentation in the consolidated balance sheets.

     The excess facilities consolidation costs will be paid over the respective lease terms through 2010.

      The goal of our 2002 restructuring program is to reduce operating expense by approximately $16 million per quarter from the third quarter 2002 level, commencing in the first quarter of 2003. We cannot assure that our restructuring programs will achieve all of the expense reductions and other benefits we anticipate. In addition, anticipated savings from reduced headcount or facility consolidations have been and may in the future be mitigated by subsequent increases to headcount and subsequent facilities additions related to our operating requirements.

      Litigation Settlement Costs. Litigation settlement costs of approximately $3.0 million were incurred in both 2002 and 2001.

      Amortization of Goodwill. Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquired company and the fair value of the net tangible and intangible assets acquired. There was no amortization of goodwill recorded in 2002. Amortization of goodwill for 2001 was $753.0 million or 78.3% of net revenue.

      The significant change in the amortization of goodwill resulted from the impact of adopting new accounting standards. In June 2001 the FASB issued SFAS No. 141, Business Combinations , or SFAS 141, and SFAS 142, both effective for fiscal years beginning after December 15, 2001. Under these new rules, goodwill and other intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives. SFAS 142 was immediately applicable to any acquisitions made after June 30, 2001. As required by SFAS 142, we ceased amortizing goodwill of $2.254 billion beginning January 1, 2002. Included in this amount is $12.1 million of assembled workforce previously classified as purchased intangible assets, which was reclassified as goodwill effective January 1, 2002 as required by SFAS 142.

      In-Process Research and Development. The amounts allocated to IPR&D were determined through established valuation techniques used in the high technology industry and were expensed upon acquisition as it was determined that the underlying projects had not reached technological feasibility and no alternative future uses existed. There was no IPR&D recorded in connection with the 2002 acquisition. IPR&D totaled $109.7 million for the four purchase transactions completed in 2001.

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      The fair value of IPR&D for each of the acquisitions was determined using the income approach. Under the income approach, the expected future cash flows from each project under development are estimated and discounted to their net present value at an appropriate risk-adjusted rate of return. Significant factors considered in the calculation of the rate of return are the weighted-average cost of capital and return on assets, as well as the risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. Each project was analyzed to determine the unique technological innovations, the existence and reliance upon core technology, the existence of any alternative future use or current technological feasibility, and the complexity, cost and time to complete the remaining development. Future cash flows for each project were estimated based upon forecasted revenue and costs, taking into account product life cycles and market penetration and growth rates.

      The IPR&D charge includes only the fair value of IPR&D performed as of the acquisition date. The fair value of developed technology is included in identifiable purchased intangible assets, and the fair values of IPR&D to be completed and future research and development are included in goodwill. We believe the amounts recorded as IPR&D, as well as developed technology, represent fair values and approximate the amounts an independent party would pay for these projects at the time of the respective acquisitions.

      The following table summarizes the significant assumptions at the acquisition dates underlying the valuations for our significant purchase transactions completed in 2001:

      We completed all of the Visiontech development projects as expected in 2001.

      ServerWorks completed two development projects during 2002. Approximately $8 million over the previous estimate was required to complete these projects. ServerWorks reallocated the resources on the remaining project to focus on next-generation semiconductor products that it believes are better aligned with future demand.

      Except as noted above, actual results to date have been consistent, in all material respects, with our assumptions at the time of the acquisitions. The assumptions consist primarily of expected completion dates for the in-process projects, estimated costs to complete the projects, and revenue and expense projections for the products once they have entered the market. Failure to achieve the expected levels of revenue and net income from these products will negatively impact the return on investment expected at the time that the acquisitions were completed and may potentially result in impairment of goodwill and other long-lived assets.

      Interest Income, Net. Interest income, net, reflects interest earned on average cash and cash equivalents and marketable securities balances, less interest accrued on our debt and capital lease obligations. Interest income, net, for 2002 was $12.2 million as compared with $23.0 million for 2001. The decrease in 2002 resulted primarily from an overall decline in both our cash and investment balances and the interest rates thereon.

      Other Expense, Net. Other expense, net, primarily includes recorded gains and losses on strategic investments as well as gains and losses on foreign currency transactions and dispositions of property and equipment. Other expense, net, for 2002 was $32.8 million or 3.0% of net revenue, an increase of $1.9 million as compared with $30.9 million or 3.2% of net revenue for 2001. In 2002 and 2001 we recorded losses of approximately $37.8 million and $32.7 million, respectively, representing other-than-temporary declines in the values of certain of our strategic investments. The losses for 2002 were offset in part by approximately $4.6 million in gains realized on sales of an investment in a publicly held company.

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      Provision for Income Taxes. We recorded an income tax provision of approximately $297.6 million for 2002 and a tax benefit of $56.7 million for 2001, which resulted in effective tax rates of approximately (15.3)% for 2002 and 2.0% for 2001. The federal statutory rate was 35% for both periods. The differences between our effective tax rates for 2002 and 2001 and the federal statutory rate resulted primarily from the effects of nondeductible IPR&D, amortization and impairment of goodwill and other acquisition-related expenses from the 13 purchase transactions completed during 2002, 2001 and 2000, as well as increases in the valuation allowance for deferred tax assets. We utilize the liability method of accounting for income taxes as set forth in SFAS No. 109, Accounting for Income Taxes . See Note 5 of Notes to Consolidated Financial Statements.

      At December 31, 2002 and 2001 we had recorded valuation allowances against deferred tax assets in the amounts of approximately $990.2 million and $375.1 million, respectively, reflecting an increase in the valuation allowance during 2002 of approximately $615.1 million. During 2002 we concluded that a full valuation allowance against our net deferred tax assets was appropriate as a result of our recent cumulative losses and the full utilization of our loss carryback potential.

     Years Ended December 31, 2001 and 2000

      Net Revenue. Net revenue for 2001 was $961.8 million, a decrease of $134.3 million or 12.3% as compared with net revenue of $1.096 billion for 2000. Net revenue was reduced by $25.5 million and $38.6 million for 2001 and 2000, respectively, to account for the fair value of the performance-based warrants to purchase shares of Class A common stock earned by certain customers in connection with purchase and development agreements that we assumed in prior acquisitions. The decline in net revenue resulted primarily from a decrease in volume shipments of our semiconductor products for the high-speed networking market, digital cable set-top boxes and cable modems, as our customers faced slower demand for their products and continued to work through their inventory issues, offset in part by shipments of SystemI/O server products. Due to the significant economic slowdown in the technology sector and semiconductor industry in 2001, we experienced a significant slowdown in customer orders, as well as an increase in the number of order cancellations and reschedulings of backlog.

      Gross Profit. Gross profit for 2001 was $404.1 million or 42.0% of net revenue, a decrease of $207.9 million or 34.0% from gross profit of $611.9 million or 55.8% of net revenue for 2000. The decrease in gross profit was mainly attributable to the decrease in the volume of semiconductor product shipments as well as non-cash acquisition-related charges, including amortization of purchased intangible assets and stock-based compensation expense. This decrease was offset in part by cost reductions in 2001. The decrease in gross profit as a percentage of net revenue for 2001 compared with 2000 was primarily a result of the non-cash acquisition-related charges and, to a lesser extent, decreased absorption of manufacturing overhead due to lower production volumes and shifts in our product mix. Approximately $15.9 million and $4.6 million of stock-based compensation expense were included in cost of revenue for 2001 and 2000, respectively. Approximately $51.7 million and $2.3 million of amortization of purchased intangible assets were included in cost of revenue for 2001 and 2000, respectively.

      Research and Development Expense. Research and development expense for 2001 was $446.6 million or 46.4% of net revenue, an increase of $196.0 million or 78.2% as compared with research and development expense of $250.7 million or 22.9% of net revenue for 2000. This increase was primarily due to the addition of personnel through acquisitions and internal hiring, investment in design tools for the development of new products and the enhancement of existing products, and the cost of additional facilities required to support the increase in headcount.

      Selling, General and Administrative Expense. Selling, general and administrative expense for 2001 was $155.4 million or 16.2% of net revenue, an increase of $52.1 million or 50.5% as compared with selling, general and administrative expense of $103.3 million or 9.4% of net revenue for 2000. This increase reflected higher personnel-related costs resulting from the addition of sales and marketing, senior management and administrative personnel through acquisitions and internal hiring as well as increased facilities expenses and legal fees.

      Stock-Based Compensation Expense. We recorded approximately $377.9 million of deferred compensation for 2001 and $1.242 billion of deferred compensation for 2000, primarily in connection with stock options assumed

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      The significant increase in stock-based compensation expense for 2001 related primarily to stock options assumed in the four purchase transactions completed during 2001 as well as the full year impact of the eight purchase transactions completed during 2000, all of which were accounted for in accordance with FIN 44.

      Approximately $35.0 million of the stock-based compensation expense recorded for 2001 related to stock options subject to variable accounting. This expense was calculated based on the amount by which our Class A common stock closing price at the end of the reporting period, or at the date of exercise, if earlier, exceeded the exercise price of the stock options.

      Amortization of Goodwill and Purchased Intangible Assets. In connection with the four purchase transactions completed during 2001 and contingent consideration earned from previous acquisitions, we recorded approximately $962.6 million of additional goodwill and $129.3 million of purchased intangible assets for 2001. For the eight purchase transactions completed during 2000, we recorded approximately $3.351 billion of goodwill and $50.3 million of purchased intangible assets for 2000. The amortization of goodwill and purchased intangible assets for 2001 was $780.2 million or 81.1% of net revenue, an increase of $642.0 million or 464.4% as compared with $138.2 million or 12.6% of net revenue for 2000. In addition, approximately $51.7 million and $2.3 million of amortization of purchased intangible assets was classified as cost of revenue for 2001 and 2000, respectively.

      In connection with our acquisitions of Allayer, SiByte and ServerWorks, we recorded $180.3 million of additional goodwill during 2001 when certain internal performance goals were met.

      Impairment of Goodwill. During 2001 we performed an assessment of the carrying values of intangible assets recorded in connection with our various acquisitions. The assessment was performed in accordance with SFAS 121, due to the significant economic slowdown and the reduction in near-term demand in the technology sector and the semiconductor industry. As a result of the assessment, we concluded that the decline in market conditions within the industry was significant and other than temporary. Based on this assessment and an independent valuation, we recorded a charge of $1.182 billion to write down the value of goodwill associated with certain of our purchase transactions. See Notes 1 and 10 of Notes to Consolidated Financial Statements.

      In-Process Research and Development. IPR&D totaled $109.7 million for the four purchase transactions completed in 2001, as compared with $713.1 million for the eight purchase transactions completed in 2000. The amounts allocated to IPR&D were determined through established valuation techniques used in the high technology industry and were expensed upon acquisition as it was determined that the underlying projects had not reached technological feasibility and no alternative future uses existed.

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      The following table summarizes the significant assumptions at the acquisition dates underlying the valuations for our significant purchase transactions completed in 2000:

      We completed all five of the Innovent development projects by the end of 2001. An additional $16.9 million over the previous estimate was required to complete these projects.

      We completed three development projects of Altima as expected during 2001. We reallocated the resources on the remaining project to focus on next-generation semiconductor products that we believed were better aligned with future demand.

      We completed all eight of the NewPort development projects as expected during 2001. An additional $4.7 million over the previous estimate was required to complete these projects.

      We completed the Silicon Spice development project as expected in 2001.

      We completed one of the Element 14 development projects during 2001. We reallocated the resources on the remaining project to focus on next-generation semiconductor products that we believed were better aligned with future demand.

      We completed one of the Allayer projects as expected during 2001. We reallocated the resources on the two remaining projects to focus on next-generation semiconductor products that we believed were better aligned with future demand.

      We completed one of the SiByte development projects during 2002. One additional project, which is currently approximately 65% complete, is expected to be completed during 2003, and we estimate the cost to complete this project will be approximately $14.0 million.

      Except as noted above, actual results to date have been consistent, in all material respects, with our assumptions at the time of the acquisitions.

      Restructuring Costs. In the second quarter of 2001 we announced and began implementing a plan to restructure our operations in response to the then current challenging economic climate. This restructuring plan resulted in certain business unit realignments, workforce reductions and consolidation of excess facilities. For 2001 we recorded restructuring costs totaling $34.3 million, which were classified as operating expense in the consolidated statements of operations.

      Through December 31, 2001 the restructuring plan had resulted in termination of the employment of approximately 160 employees across all business functions and geographic regions. We recorded workforce

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      Through December 31, 2001 we recorded charges of approximately $18.2 million for the consolidation of excess facilities. The charges related primarily to lease terminations and non-cancelable lease costs.

      Litigation Settlement Costs. Litigation settlement costs of approximately $3.0 million were incurred for 2001. No comparable litigation settlement costs were incurred for 2000.

      Merger-Related Costs. In connection with the pooling-of-interests transactions in 2000, merger-related costs of approximately $4.7 million were incurred. No merger-related costs were incurred for 2001 as there were no business combinations accounted for as poolings of interests. Merger-related costs consist primarily of transaction costs, such as fees for investment bankers, attorneys, accountants and other related fees and expenses, incurred in acquisitions as well as certain restructuring costs related to the disposition of duplicative facilities and assets and the write down of unutilized assets.

      Interest Income, Net. Interest income, net, for 2001 was $23.0 million as compared with $24.3 million for 2000. The decrease for 2001 was the result of interest expense incurred on debt assumed from our ServerWorks acquisition and an overall decline in interest rates on our investments, partially offset by increased cash balances available to invest resulting from the cash generated by operations, cash balances assumed in acquisitions, and cash received from the exercise of employee stock options.

      Other Expense, Net. Other expense, net, primarily includes recorded gains and losses on strategic investments as well as gains and losses on foreign currency transactions and dispositions of property and equipment. For 2001, other expense, net, was $30.9 million as compared with $2.7 million for 2000. During 2001 we recorded a loss of approximately $32.7 million representing an other-than-temporary decline in the value of our strategic investments.

      Provision for Income Taxes. We recorded income tax benefits of approximately $56.7 million for 2001 and $4.0 million for 2000, which resulted in effective tax rates of approximately 2.0% for 2001 and 0.6% for 2000. The federal statutory rate was 35% for both periods. The differences between our effective tax rates for 2001 and 2000 and the federal statutory rate resulted primarily from the effects of nondeductible IPR&D, impairment of goodwill and other acquisition-related expenses from the twelve purchase transactions completed during 2001 and 2000, as well as the effects of certain 2001 losses recorded without tax benefit.

      At December 31, 2001 and 2000 we provided valuation allowances against deferred tax assets in the amounts of approximately $375.1 million and $6.9 million, respectively, resulting in an increase in the valuation allowance in 2001 of approximately $368.2 million. There was no valuation allowance provided against the remainder of our deferred tax assets, as we believed that it was more likely than not that these assets would be realized. The primary bases for this conclusion were the expectation of future income from our ordinary and recurring operations and tax planning strategies, which relied on our continuing ability to realize value from our intellectual property portfolio.

Impact of Adoption of Accounting Standard

      In June 2001 the FASB issued SFAS 142. Under these new rules, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. Other intangible assets will continue to be amortized over their estimated useful lives.

      As required by SFAS 142, we ceased amortizing goodwill of $2.254 billion beginning January 1, 2002, which includes $12.1 million of assembled workforce previously classified as purchased intangible assets, which was reclassified to goodwill effective January 1, 2002 as required by SFAS 142.

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      The following table presents the impact of SFAS 142 on net loss and net loss per share had the standard been in effect for the years ended December 31, 2001 and 2000:

Recent Accounting Pronouncements

      In June 2002 the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities , or SFAS 146, which nullifies Emerging Issues Task Force, or EITF, Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) , or EITF 94-3. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF 94-3 required that such liability be recognized on the date on which the company had committed to an exit plan. We are required to adopt the provisions of SFAS 146 effective for exit or disposal activities initiated after December 31, 2002. We do not expect the adoption of SFAS 146 to have a material impact on our financial condition or results of operations.

      In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others , or FIN 45, effective prospectively for guarantees issued or modified after December 31, 2002. Under this Interpretation, a guarantor is required to recognize, at the inception of certain guarantees, a fair value liability for the obligations it has undertaken in issuing the guarantee. We did not have any outstanding guarantees at December 31, 2002 required to be recorded as obligations upon adoption of FIN 45. Our product warranties, which are subject to the disclosure provisions of FIN 45, have been disclosed in the accompanying consolidated financial statements.

      In December 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure , or SFAS 148, which amends SFAS No. 123, Accounting for Stock-Based Compensation , or SFAS 123. SFAS 148 amends the disclosure requirements in SFAS 123 for stock-based compensation for annual periods ending after December 15, 2002 and interim periods beginning after December 15, 2002. The disclosure requirements apply to all companies, including those that continue to recognize stock-based compensation under APB Opinion No. 25, Accounting for Stock Issued to Employees . Effective for financial statements for fiscal years ending after December 15, 2002, SFAS 148 also provides three alternative transition methods for companies that choose to adopt the fair value measurement provisions of SFAS 123. We have not elected to adopt the fair value measurement provisions of SFAS 123.

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Liquidity and Capital Resources

      Working Capital and Cash and Marketable Securities on Hand. Since our inception we have financed our operations through a combination of sales of equity securities, cash generated by operations and cash assumed in acquisitions. Including restricted marketable securities, at December 31, 2002 we had $187.8 million in working capital, $502.7 million in cash, cash equivalents and short-term marketable securities and $40.2 million in long-term marketable securities. Marketable securities are defined as income yielding securities that can be readily converted into cash. Certain marketable securities are pledged as collateral against our bank credit facility and consequently are classified as restricted securities. At December 31, 2001 we had $265.1 million in working capital, $539.8 million in cash, cash equivalents and short-term marketable securities and $109.8 million in long-term marketable securities.

      Our working capital decreased in 2002 primarily due to our operating loss, additions to property and equipment, liabilities recorded in connection with our restructuring activities, and the assumption of net liabilities in the Mobilink acquisition.

      Cash Provided and Used in 2002 and 2001. Cash and cash equivalents decreased from $403.8 million at December 31, 2001 to $389.6 million at December 31, 2002 as the cash provided by investing and financing activities was more than offset by cash used in operations.

      During 2002 our operating activities used $69.2 million in cash. This was a result of our net loss of $2.237 billion, which was offset in part by $2.128 billion in non-cash items and $15.0 million in cash provided by changes in net operating assets and liabilities. Non-cash items included in net loss include impairment of goodwill, depreciation, stock-based compensation expense, amortization of purchased intangible assets, certain restructuring charges, valuation allowance on deferred taxes, and net losses on strategic investments. During 2001 operating activities provided $49.1 million in cash. Although we had a net loss of $2.742 billion for 2001, such amount included non-cash items aggregating $2.660 billion resulting from depreciation, stock-based compensation expense, amortization of goodwill and purchased intangible assets, impairment of goodwill, IPR&D, certain restructuring charges, valuation allowance on deferred taxes, and losses on strategic investments. In addition to the impact of non-cash items, our 2001 operating activities also reflected decreases in accounts receivable and inventory, offset in part by decreases in other accrued liabilities.

      Accounts receivable increased $62.9 million to $128.2 million during 2002. The increase in accounts receivable resulted primarily from the increase in net revenue in the fourth quarter of 2002 as compared with the fourth quarter of 2001 and due to the fact that our sales were fairly consistent throughout the quarter, as opposed to the fourth quarter of 2001 in which a higher proportion of sales occurred in the first two months of that quarter.

      Inventories increased $23.8 million to $46.0 million during 2002. The increase in inventory was to support our increased revenue levels and entry into certain markets that require higher inventory levels.

      Investing activities provided cash in the amount of $22.4 million in 2002, primarily as a result of $100.0 million in net proceeds received from the sale of marketable securities and strategic investments, offset in part by the purchase of $75.2 million of capital equipment to support our operations and the purchase of $3.3 million of strategic investments. Our investing activities used cash in the amount of $216.8 million in 2001, primarily as a result of $166.1 million of net purchases of marketable securities, the purchase of $71.4 million of capital equipment to support our operations and the purchase of $20.3 million of strategic investments, offset in part by $41.0 million of net cash acquired in purchase transactions.

      Cash provided by financing activities was $32.5 million in 2002, which was primarily the result of $44.1 million in net proceeds received from issuances of common stock upon exercises of stock options and under our employee stock purchase plan, partially offset by $13.7 million in payments on debt and capital lease obligations. Cash provided by financing activities was $47.6 million in 2001, which was primarily the result of a $90.0 million bank credit facility secured to replace the ServerWorks credit facility that was repaid in 2001, $59.8 million in net proceeds received from issuances of common stock upon exercises of stock options and under our employee stock purchase plan, and $25.5 million in net proceeds from the exercise of performance-

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      Due to the continued decline in our stock price, we received fewer proceeds from the exercise of stock options in 2002 than we did in 2001, as only options with lower exercise prices were exercised. In the future we may not generate as much cash from the exercise of stock options as we have in the past.

      Obligations and Commitments. The following table summarizes our contractual payment obligations and commitments as of December 31, 2002: